Merging Housing and Energy Concerns

I've written quite a bit about the state of the housing market and its fundamental importance to the U.S. economy. I've also written about the long-term consequences of rising energy prices on global trade and the structure of economies. RealMoney'sGlenn Williams has written many times about the lack of a national energy policy and the problems associated with a national power grid that's beholden to state and local interests.

I'm going to mesh these ideas together and discuss practical, pragmatic and politically viable ways Congress and President Obama could help promote growth in the housing sector while also promoting energy-efficient technologies. But first, we need a series of assumptions. (Please don't focus on where each of these assumptions may be debated, focus on the long-term, macro effect. I'm happy to address questions concerning the assumptions later.)

Housing Assumptions

There are about 90 million single family dwellings in the U.S.

Current new home creation is about 400,000 annually, which provides a replacement average of 225 years.

U.S. population and household formation is increasing at about 1% annually.

The real replacement rate of existing housing stock is 1% annually.

Electric Power Assumptions

Most electricity in the U.S. is created through the use of natural resources.

Green energy is both a production and a consumption concern.

Nuclear energy growth in the U.S. is not immediately viable.

The vast majority of U.S. housing stock was built when energy efficiency was not a concern. Today, however, there is growing recognition that the costs of producing and delivering electricity to residential properties is increasing faster than the rate of inflation. As a result, there is growing recognition that green energy needs to be focused both on the production side and on the consumption side. This may sound like common sense, but it hasn't always been so.

The primary focus within the energy industry and by government agencies has been to promote the production of renewable energy sources in place of non-renewables. This means replacing coal with wind, solar, and geothermal energy.

There has also been a quiet assumption within the energy industry and the government that eventually there would be a renaissance of nuclear-energy production. With the recent nuclear disaster in Japan, as well as regulatory hurdles in the U.S., it looks increasingly unlikely that will happen.

The back story is that it has long been assumed within the energy industry, as well as by government authorities, that if peak oil was indeed real and, as a result, oil prices rose, causing gasoline prices to crimp economic activity, the benefit would be that it would provide the economic incentive for the private sector to invest in the transition to natural gas-based fuel systems for cross-country vehicles.

Shifting to natural gas as fuel for internal combustion engines and away from producing electricity would force the government to pursue nuclear energy as a replacement. But this doesn't look viable. It still leaves us with peak oil and the need to transition to natural gas fuel systems for automobiles, but without a viable green replacement for it in the production of electricity.

From a national policy standpoint, it's very difficult for the federal government to promote a production system that avoids substantial supply issues as this process unfolds, as Glenn Williams has written previously. The federal government, however, can unilaterally provide tax incentives to promote a reduction in the consumption of electricity immediately.

This is where the housing sector and energy policy converge to create the opportunity for a win-win-win scenario. In other words, job creation and economic activity increase, energy consumption decreases while energy efficiency increases, and tax revenue rises as a result.

Since the collapse of Lehman Brothers there have been multiple fiscal stimulus programs by the federal government. The most high-profile initiative was the American Recovery and Reinvestment Act of 2009. Two sections of the recovery act targeted the housing sector: an $8,000 first time home buyer tax credit, and a credit of up to $1,500 for homeowners to upgrade energy efficiency.

The problem with both stimuli is that they are too small, restrictive and short-lived to provide the needed incentives for job creation. The incentives were focused on individual homeowners, limited to 30% of the costs of upgrading, and expired in 2010. That is short-term stimulus. I won't discuss tax incentives for purchasing other than to say it was an inefficient allocation of resources. I will say that tax credits to individuals to retrofit existing housing stock with energy-efficient products should be expanded.

The time limit is supposed to provide a takeaway sale mentality that gets consumers to act quickly before the incentives expire. The problem, however, is that it discourages companies from investing in jobs. What needs to be done is for the program to be moved from a short stimulus package to a long-term tax structure, with deeper and broader incentives to individuals to participate. As more people participate, a virtuous cycle of participation will cause job creation in the sector to expand.

Creating jobs in the sector requires almost no capital outlay by companies. By implementing the tax incentives, the resulting demand for energy efficient retrofitting creates jobs.

There is also an inertia synergy that the government can capitalize on immediately. As home prices stagnate in real terms for the next several years, existing home owners will be more predisposed to upgrading their existing homes than moving. This same phenomenon occurred in the U.S. following the Savings and Loan crisis of the late 1980s and early 1990s.

The public companies best positioned to profit from a shift in tax incentives for energy efficiency from temporary to permanent status are Home Depot (HD) and Lowe's (LOW). Home Depot's stock increased from roughly $0.50 a share in 1987 to $10 in 1992. Lowe's went from about $0.50 to nearly $5 a share in roughly the same time frame. Both capitalized on homeowners upgrading existing properties that were stagnating in value.

I am watching for signs of a move in this direction by Congress and the president. It might take another leg down in housing and rising energy costs for them to recognize the advantage. So, I am cautious about it and don't expect any public discussion until next year as the presidential race gets going and the incumbent needs an economic plan that voters will support.